FEMSA Has The Pieces In Place For The Next Round Of Growth

caio acquesta/iStock Editorial via Getty Images The shares of FEMSA ( FMX ) haven’t performed all that well since my last update, declining about 10%, lagging the S&P 500, the Bolsa, and Wal-Mart de Mexico ( OTCQX:WMMVY ) (“Walmex”). I believe at least some of this underperformance is due to ongoing concerns about the company’s M&A program in U.S. janitorial and sanitation distribution, with the company spending over $1B to acquire several businesses.

The Street has taken a “show me” stance with FEMSA, and that’s understandable to a point, given this foray into a new market and concerns about the pace of the in-store traffic recovery at OXXO. Still, I believe the Street is taking an overly pessimistic and short-sighted approach, particularly as the company’s new Spin digital wallet can drive meaningful high-margin revenue in the years to come, not to mention ongoing growth opportunities in the core retail operations.

Not much has changed in my basic modeling for FEMSA; I’m still expecting mid-to-high single-digit long-term revenue and FCF growth, with improving margins and free cash flow as investments in distribution and financial services pay off over time. Mixed Results To Close The Year

FEMSA’s fourth quarter results weren’t bad, but I expect that the margin underperformance in the quarter will probably be top of mind for many analysts and investors for the near future.

Revenue rose more than 16% as reported and almost 13% in organic terms, beating by around 4%. Gross margin declined 40bp to 39.5%, with EBITDA up 12% (about 11% in organic terms), and operating income up 18% as reported (with margin up 10bp to 10.2%). EBITDA was just in line with expectations, with margin about 50bp short of expectations at 15.5%.

Coca-Cola FEMSA ( KOF ) reported over 8% year-over-year revenue growth (over 10% in constant currency terms), with volumes up more than 5% and healthy growth in Mexico/Central America (up over 7%) and South America (up almost 12%) offsetting weakness in Brazil (down 1%). EBITDA was up more than 6%, with margin down 40bp to 20.0%.

Comercio, the segment that includes the OXXO convenience stores, saw better than 14% revenue growth, with same-store sales growth accelerating to over 12%. That’s not too far out of line with overall retail same-store growth in Mexico during the quarter (ANTAD reported growth of 11.6%, 9.3%, and 13.7% in the last three months of 2021), though the still-sluggish traffic (up 2%) is more concerning. EBITDA rose more than 25%, with margin up more than two points to 18%.

The drugstore business (“Health”) saw 7% reported revenue growth and 14% constant currency growth, with same-store sales up 5.7% as reported and over 10% in constant currency. Health EBITDA was up just 2%, with margin down 50bp to 9.7%.

The fuel business reported 30% year-over-year sales growth, but revenue is still down about 10% relative to 2019 levels. Same-store sales were up more than 23% on 8% volume growth, but still down almost 15% relative to 2019 levels. EBITDA rose 29%, with margin down 10bp to 6.3%.

Finally, the logistics and distribution business posted 25% quarter-over-quarter growth (annual comparisons aren’t useful), boosted by ongoing M&A. EBITDA margin was basically stable with the third quarter at 10.6%. The Distribution Business Should Be A Multiyear Operating Leverage Story

FEMSA’s foray into U.S. janitorial and sanitation distribution has been controversial to say the least, as many analysts and investors expected the company to either extend its c-store chain OXXO into the U.S. or expand it more aggressively into other Latin American markets.

I’m sympathetic to these concerns to a point. Distribution can be a low-margin business, and two of FEMSA’s largest rivals, Bunzl ( OTCPK:BZLFY ) and Veritiv ( VRTV ), have struggled to generate EBITDA margins much above the mid-single-digits on a sustained business in the respective comparable businesses. Moreover, given that the FEMSA footprint still has gaps (Texas, the Gulf Coast, and some of the Midwest/Upper Midwest), I’d expect further M&A activity.

I’m not going to sing the praises of the jan/san distribution growth strategy. I do expect meaningful scale advantages as the company integrates its acquisitions and achieves national operating scale, and the business should throw off attractive cash flows given lower ongoing capex needs, but FEMSA management really needs to do a better job of explaining to investors what it can do differently/better than its competitors, and how this expansion plan will generate long-term ROIC in excess of the cost of capital.

On the logistics side, I’m much more bullish on the opportunities for FEMSA to […]

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